Cost of Fee Switch
activating the protocol fee comes at a cost
Alex @lajarre | π§ Butter
EBS 2023-11-07
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Agenda
- π¦ Uniswap model
- π§πΌ Attack
- π° Funding mechanism
- π€― Teachings
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π¦ Uniswap model
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Uniswap v2 fork competition game
Model:
- 2 competing AMMs
- A β B pools
- Swappers allocation:
cost β price impact - LPs allocation:
revenue β volume
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Swappers allocation
Price impact:
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See Angeris et al: "An analysis of Uniswap markets", 2019
Swappers allocation
Utility:
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π§ allocate more towards AMM with larger reserves
Swappers allocation
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π§ marginal allocation
towards AMM
with larger volume
LPs allocation
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Equilibrium under network effects
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π§πΌ Attack
fork + subsidy = liquidity flight
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Simple model:
- fee switched on forever
Fee switch
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Intuition:
- If fee switched on, then no-fee competitor captures more than its fair share.
- Use this extra volume to fund a subsidy.
- With enough subsidy, network effects move equilibrium towards competitor.
Allocation game
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π§ at equilibrium, subsidy makes LP allocation indifferent
π§ equilibrium +Ξ΅ counteracts network effects: liquidity flight
Subsidy
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β οΈ reallocation will be lower because of switching costs
(brand, smart contract risk, legalβ¦)
V = 10^8 USD
R = 10^7 USD
R_1(0) = 100%
Total cost
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π° Funding mechanism
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Intuition:
- AMM 2 has no fee switch in its governance surface
- raise debt rather than equity to fund the subsidy
- funding via governance mechanism or crowdfunding
Funding mechanism
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Subsidy funding
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π§ avoid equity-like funding: capture via wealth condensation
π§ if governance surface:
Debt(GovernanceFutureRevenue)
β‘οΈ parameter auctions
β‘οΈ proposal auctions
β‘οΈ auctions & futarchy
π§ crowdfunding: LPs and swappers will fund if more efficient (coasean argument)
Source of funds
see https://ethresear.ch/t/governance-mixing-auctions-and-futarchy/10772
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what does this prove about governance?
π€― Teachings
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π§ XV is the present value extracted by UNI tokenholders out of the protocol
π§ XV is limited by the attack:
- either Ο > 0 is fixed: volume will be reduced ultimately to 0
- either Ο is modulated to limit liquidity flight
Upper limit on eXtractible Value
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π§ forking & smart contracts influence governance
π§ grim trigger on UNI tokenholders
Internalize externalities
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π π§
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